Growth Decomposition and Productivity Trends Leonardo Garrido and Elena Ianchovichina PRMED March 23, 2009

Possible growth decompositions  Contribution of demand components  Sectoral contribution to growth  Growth accounting 2

Contribution of Demand Components to Growth (I)  What are the proximate drivers of growth in aggregate demand? Departs from fundamental equation Y=C+I+G+X-M Aggregate supply = Y+M Aggregate Demand = C+I+G+X  Steps: 1. Calculate annual growth rate of each component of aggregate demand 2. Calculate shares of each component of aggregate demand 3. Calculate the contribution to growth of each component by multiplying growth rates of demand components times share of component in aggregate demand 3

Contribution of Demand Components to Growth (II): The Case of Egypt. 4

Sectoral Contribution to Growth  Similar approach to demand contribution to growth Uses GDP at factor costs (not at market prices) which equals the sum of GDP of economic activities Imputed financial services not excluded from each economic activity (assumption of financial services proportion to sectoral GDP)

Growth Accounting (I)  With CRS Hicks Neutral Cobb Douglas production function  Taking logs and differentiating 6

Growth Accounting (II)  GDP data in real terms. All series to be expressed in same currency unit and base year  Factor shares: Obtained from National Accounts.  is the ratio of compensation to capital (Net operating Surplus) to total GDP at factor costs. Assumption of CRS can be tested if times series of compensation to capital and labor are available for the analyzed period. The labor share  (=1-  with CRS) can be calculated from National Accounts as the ratio of remuneration to labor to GDP at factor costs  Capital services are assumed to growth at same rate as capital stock (which implicitly says that no changes in capacity utilization occur during the analyzed period) 7

Growth Accounting (III)  Capital stocks (K) estimated from perpetual inventory method, given the depreciation rate (d) and the Investment flow (I): K t = K t -1*(1-d t ) +I t Capital Stock data available from Nehru and Dhareshwar (1993)  Employment data expressed in number of workers per year If available, use number of hours worked by period  Human Capital accumulation proxy-ed by education attainment. With different categories of education (primary, secondary, tertiary) a Human Capital Index may be weighted by means of Returns to Education in each category. 8

TFP as a proxy to returns to capital accumulation  Problems with TFP (and growth accounting, in general) TFP is a “measure of our ignorance” Imperfect measures of factors of production Natural resources not included Factor shares as elasticities of output to changes in output constitutes a strong assumption Is Cobb-Douglas an adequate functional form?  Alternative measures for returns on capital accumulation Ratio of Net operating Surplus (From National Stocks) to capital stocks (estimated from perpetual inventory method) 9

Case example 10

Is the rate of return on economic activity low?  Assess TFP growth using growth decomposition at the aggregate level Look at the TFP and factor accumulation trends Look at the estimates in recent years and the final year Conduct sensitivity analysis to see whether the finding are sensitive to changes in the qualitative findings  The aggregate TFP growth estimates may be misleading: it is important to look at sources of growth 11

The case of Mongolia. Efficiency has improved… 12 Source: Ianchovichina and Gooptu (2007)

Sensitivity analysis  Productivity growth was positive in 2004 under: Different values for the parameters Different functional forms 13

Sectoral decomposition Not all sectors enjoyed high returns to capital  Returns to capital in manufacturing and transport were negative  Returns in agriculture were very volatile 14

What do these results tell us?  Growth in Mongolia has been narrowly-based  Driven by the booming mining and real estate sectors  Mongolia has remained vulnerable to terms-of-trade changes  Large part of Mongolia’s labor force employed in low-productivity activities 15

The case of Benin Efficiency has declined… 16 Source: Ianchovichina (2008) based on the following assumptions: Cobb-Douglas production function with CRTS and capital share α=0.4.

Sensitivity analysis  Result for 2006 is robust to changes in specifications  We rule out the possibility that this productivity deterioration was due to negative TOT shocks as Benin’s TOT remained unchanged in the period

Need to rule out exogenous shocks 18 Source: Ianchovichina (2008) and Benin CEM, Chapter 1

Over the years Benin grew primarily through expansion of capacity, not more efficient use of existing capacity 19 Source: Ianchovichina (2008) and Benin CEM, Chapter 1

Industry has stagnated… Key drivers of growth: agriculture and trade 20 Source: Ianchovichina (2008) and Benin CEM, Chapter 1